The BP (LSE:BP) share price has been faltering in recent weeks and is down 15% in the past month. The firm’s profitability is very much dependent on the price of oil, which has been hammered by a lack of demand. Coronavirus has undoubtedly created a challenging year for oil companies and the majors are not exempt. How oil giants like BP and Shell proceed over the coming months will determine their future profitability and growth.
Laying the groundwork for a stronger share price
Although it is depressing for existing shareholders to see constant volatility in the BP share price, patience is key. The £62bn company appears to be sensibly opting to streamline its business and hone its strategy towards a profitable future. On Monday BP announced it is selling its petrochemicals business to Ineos, the chemicals giant, for $5bn. It expects this to complete at the end of the year. The sale brings its targeted divestments of $15bn to completion a year earlier than planned. It will also strengthen its balance sheet when cash on hand is more important than ever. This move also ties in nicely with BP’s goal to reinvent itself.
BP has a price-to-earnings ratio of 19, earnings per share are 16p and its dividend yield remains at 10% for now. This dividend makes it a very tempting FTSE 100 stock, but analysts say a cut is likely later in the year.
$100 oil is a long way off
Since the pandemic, OPEC+ members agreed to an unprecedented level of production cuts to reign in the amount of oil in storage. Meanwhile, US shale companies, not in agreement with OPEC+, have been scrambling to keep producing and storing as much as possible. A low oil price makes it harder for shale companies to remain profitable because shale is more expensive to produce than crude. This has resulted in a slew of job losses and bankruptcies, including high-profile shale driller Chesapeake Energy.
While US rig counts have been reducing, its oil inventories have been rising, reaching a record-breaking high of 541m barrels in June. You may wonder what impact the goings-on of the US energy market have on UK oil stocks, but it is important to remember the world’s oil market is intertwined. If the US has an oversupply of oil, this will suppress the oil price.
As Britain begins to open up again, the World Health Organisation has warned the coronavirus pandemic will get worse before it gets better. It is rampaging through America and the third world, and second waves are spiking in some countries that have already eased lockdown.
At the moment it looks like the oil price will stick around the $40 a barrel mark until the end of the year. On the one hand, if shale production falls far enough and global demand for oil explodes, then $100 oil could be a reality. On the other hand, cheap oil from the Middle East and a slow resurgence in demand means the likelihood of $100 oil is a distant dream. If coronavirus is eradicated, demand should return rapidly, but if countries reinforce strict lockdowns in response to second waves of the virus, recovery will be slow.
Yet I think the BP share price is cheap and is a good addition to a long-term investors portfolio, as even a 50% dividend cut would still make this a good income stock.
